Question

What kind of supply shock do you expect in the market when the rice crop is severally damaged by the drought? How will the market adjust itself to the supply shock? What suggestions would you offer to tackle the problems arising out of the supply shock?

Answer 1

When a drought severally damages the rice crop, output of rice will significantly fall. It leads to supply shock in the market. The supply of rice decreases: supply curve shifts to the left, as in Fig. S is the initial supply curve, and D the initial demand curve. E is the point of initial equilibrium. OQ is the equilibrium quantity and OP the equilibrium price.

The supply shock (caused by the drought) shifts the supply curve from $S$ to $S_1$ ; supply of rice decreases. As a result, there is deficient supply (or excess demand) = RE. The pressure of demand causes price to rise. The rise in price leads to extension of supply and contraction of demand. supply extends from point R towards point $E_1$. Demand contracts from point $E$ towards point $E_1$. New equilibrium is established in the market at point $E_1$ The equilibrium quantity reduces from $OQ$ to ${OQ}_1$. The equilibrium price increases from $OP$ to ${OP}_1$.

The problem that emerges has two dimensions:
(i) high price of rice, and

(ii) low supply of rice.
The problem of high price of rice can be addressed by fixing a price ceiling. The government can fix maximum price of rice in the market. Any attempt to charge higher price, higher than the ceiling price would attract a legal action.
The problem of low supply of rice can be addressed in two ways: (i) The government can release more rice from its buffer stocks, and (ii) The government can import rice from rest of the world.